When you are ready to expand your existing business, your greatest problem will probably be finding enough cash to satisfy your expansion agenda.
The alternatives financing options available to you include:
- Using your own money
- Obtaining a bank loan
- Utilising hire purchase
- Leasing the asset
- Short term renting/hiring
The following table compares the relative merits of buying, leasing and renting.
|Bank Loan||Hire Purchase||Leasing||Renting/Hiring|
|Ownership||You retain ownership||Ownership is retained by the lender, but you are treated as owner for tax purposes.||Lessor retains ownership but lessee usually has option of buying at end of lease term.||Ownership retained by the provider.Hirer obtains use of the asset for a specified time.|
|Cash Flow||Cash flows are spread over the period of the loan.Interest deductions and depreciation in early years of ownership.||May have some cash flow advantage when there is a balloon payment at
end of lease.Interest deductions and depreciation in early years of ownership.
|Lower payments than loansCash flow benefits arising from tax deductions for lease payments generally spread over term of lease.||Payments are only made when goods are actually being used (can be short-term).|
|Taxation||Asset is depreciable on the basis of its effective life.Interest component is tax deductible.||Asset is depreciable on the basis of its effective life.Interest component is tax deductible.||Entire lease payments tax deductible to lessee.No tax deduction available for depreciation.||Rental payments tax deductible.|
|Cost||Down payment usually required. Usually cheapest option||Down payment usually required. Interest rate higher than bank loan||No down payment. Lease costs often comparable with bank loan||No down payment.Usually most expensive option for longer term use|
|Installation||Owner responsible for installation.Installation costs part of capital cost of asset for purpose of
|Owner responsible for installation.Installation costs part of capital cost of asset for purpose of depreciation.||Installation costs included in amount subject to lease – therefore indirectly included in payments.||Installation costs borne by hirer|
|Payments||Loan payments calculated to include interest and principal repayments, to reduce principal owing to nil by end of loan term.||Loan payments calculated to include interest and principal repayments,
to reduce principal owing to nil by end of loan term.
|Lease payments calculated to contain financing component (interest) and principal reducing to a residual value by end of leaseLessee may be required to make up difference between lease residual
value and disposal value of goods
|Rental payments not usually based on a principal and interest calculation.|
|Balloon Payment*||None||May have balloon payment at start or end of loan term.These are tax deductible when they represent outgoing finance for loan
or hire purchase.
|Balloon payments often used to better meet lessee’s cash flow, taxation and other needs. Not deductible if they represent an outgoing of capital.||None|
|Maintenance||Owner responsible and cost generally deductible.||Owner responsible and cost generally deductible.||Lessor is usually responsible for maintenance, but some leases may have
separate maintenance agreement.
|Owner responsible for maintenance.|
|Insurance||Owner responsible||Owner responsible||Lessee responsible||Owner responsible|
|Disposal of Assets||Owner free to dispose of assets at any time, subject to any fixed or floating charge lender may have over them. Difference between sale price and tax depreciated value is taxable.||Owner free to dispose of assets at any time, subject to any fixed or floating charge lender may have over them.Difference between sale price and tax depreciated value is taxable.||Lessee must first terminate lease agreement and pay penalties.Difference between sale price and tax depreciated value is taxable.||Hirer cannot dispose of goods.|
*Loans where the principal is not paid off over the life of the loan usually include a “balloon” payment to make up the difference when the loan term expires. Look for this in your lease or hire purchase agreement otherwise it can be a nasty shock.
Other Financing Options
Using Your Own Money
If you have enough cash available, this is the simplest solution. Simply inject these further funds into the business. However, you may have a more productive personal use for your money and you may prefer to finance these assets using external funds.
Once again, a matter of personal choice. Much will depend on your availability of cash and your personal financial commitments. It is important that you achieve a balance, rather than have all your money invested in the business.
External financing may be the best alternative. It is sometimes relatively easy to borrow for capital expenditure where the assets are identifiable and they have a realistic resale value.
Obtaining A Bank Loan
A bank loan is usually the cheapest form of external finance. The bank may ask you to come up with a down payment and require you to pledge other assets, such as your house or an outside investment, as collateral. Banks also usually demand that directors of companies provide personal guarantees.
Now that you have been in business for a while, a bank may be more receptive to lending you money. Provided you have a steady profit history and strong cash flow, finance should be available.
Banks publish a base overdraft rate, to which they add a margin depending on how much risk the banks feel applies to each loan. Bank loans for the purchase of assets are usually for set periods of up to 10 years and are paid off by set monthly payments.
Interest rates may vary during the life of the loan. A bank loan is usually the cheapest form of finance, but must usually be ‘secured’ by an asset (eg. family home).
Utilising Hire Purchase
Hire purchase is often preferred for financing long-term moveable assets. It requires you to make a down payment and to pay off the rest (both interest and capital) over a period, usually five years or less. The interest rate charged is usually higher than for a bank loan, but repayments are fixed under the initial contract.
The hirer retains ownership of the asset until the final payment is made (at which time you take ownership) and the hirer may repossess the asset if payments fall behind.
For taxation purposes, you may claim depreciation against tax on assets acquired under hire purchase. For this reason, hire purchase is seen as a viable alternative to a bank loan, where depreciation rates on assets acquired may not be as attractive.
Leasing is attractive as the lessee (user of the goods) does not own the asset, they are merely ‘renting’ the asset. Therefore, you can ‘hand back’ the asset after a period of time.
You may prefer leasing because it lets you avoid technical obsolescence without overspending – for example, a large percentage of computers are leased and replaced or upgraded within 24 to 48 months – so you could lease a computer and replace it regularly. You are also not committed to buying the asset.
Leases require no down payment and normally no collateral. When you lease equipment, a leasing company either buys or already owns the equipment. At the end of the lease you usually have the choice of buying the equipment, returning it or extending the terms of the lease.
Most leases include periodic maintenance, insurance and discounts on consumable parts.
In addition to ‘freeing up’ your cash and leaving your conventional lines of credit open, lease payments are usually 100 percent tax-deductible as a business expense.
Compare this to bank loans where only the interest portion is deductible. Therefore, this sometimes makes leasing more favourable than borrowing.
However, you cannot claim for depreciation on leased equipment, unlike equipment purchased under a loan or hire purchase agreement. So, there is a ‘trade-off’ with any financing decision.
Before you sign any lease, be sure you understand all the terms and conditions of the agreement. If you decide two months after you sign the lease that you don’t need the equipment or need another type, you could experience problems.
Some companies won’t release you from the contract, which could leave you paying for unneeded equipment for years, others will charge you a hefty fee to terminate the contract.
Your accountant can help you decide whether leasing is a good option for you and recommend the types of leases that suit your specific needs.
Go over the following questions with him or her, then question the company you plan to lease from.
What specific types of equipment do I need to grow my business, and for how long will I need this equipment?
What can I afford in monthly payments?
How are the payments calculated?
What are the tax pros and cons?
Can I get a sample copy of the lease being offered so my accountant and I can study its terms at our leisure?
How is this lease terminated?
What are the buyout options? Are they negotiable?
Can I upgrade at no cost? If so, within what time limits?
How flexible is the payment schedule?
Are there any incentive programs available?
What’s the average turnaround time on my application?
What are the conditions for servicing or replacing the equipment? Is there a 24-hour maintenance service?
What are the maintenance estimates on the equipment? Am I responsible for ordering and paying for replacement parts, such as printer toner?
Are shipping costs, installation, training or warranties included in the payments?
Will I be charged documentation fees? What are the late-charge fees?
Once you’ve answered these questions, slow down. Don’t jump into the first lease offered. Take the time to shop around for the equipment you need and the lease that is most appropriate for your cash flow, business needs and income.
When you accept delivery, check out the equipment thoroughly to make sure it meets your specifications.
Ask questions and get responses in writing, if necessary. Leasing equipment can be a boon to business people who are short on capital but long on potential; just make sure you understand how it affects your financial picture and future growth.
Above all, don’t sign up until you understand every clause in the lease you’re considering and its implications for your future growth.
Renting And Hiring
Short term rental of equipment, such as computers or extra vehicles, can be worthwhile to deal with very busy periods and for specialised tools and equipment which are rarely used.
Hiring is usually expensive but it is a viable option when it is only a short term need. All costs are normally tax-deductible.
Any person wanting their business to grow should consider all their financing options. Assess each in detail and choose the method you believe will optimise your position. It is recommended that you discuss your conclusions with your accountant or financial adviser.
There are a myriad of issues to consider (as per the previous table), so you need to make a well-considered, informed decision.